Planning Through Uncertainty

Financial Planning & Analysis (FP&A) software is a category of business software application (B2B) recognized by most analysts. This category of software enables companies to go beyond the limitations of spreadsheets and to perform financial planning, reporting, and analysis, more easily and collaboratively. It is also called Corporate Performance Management (CPM), Enterprise Performance Management (EPM), or Business Performance Management (BPM) software, depending on the vendor.

This white paper examines how market volatility emphasizes the need for business planning and positions these changes in the context of state-of-the-art FP&A.

How Planning Has Changed

Not very long ago, the main (and often the only) planning exercise undertaken by a company was preparing the annual budget. Budgeting was a formal process managed by the Office of Finance, the result of which was a plan at the general ledger level of detail. The Finance team presented the budget to the board or senior management for approval and was, in many companies, an authorization to spend. If an expense was in the budget then managers would assume that they could spend the money.

The annual budget was also connected to compensation, and departmental bonuses were usually based on achieving revenue targets. To do this, it was necessary to calculate variances – achieving 120% of the budget would pay a bigger bonus than achieving 110%.

In this way of running a business, planning is relatively unimportant. Preparing the budget is an annual process that involves mainly finance people. People outside of finance are more concerned with their variable compensation and their ability to hire more staff.

But now, the way companies plan is changing. They plan in more detail for a variety of reasons:

  1. Modern ERP systems allow for more detailed or ‘granular’ data in the general ledger. Financial transactions can be allocated to many different reporting entities, such as department, project, product, etc.
  2. Granularity can also extend to time. Instead of planning just once a year, most companies want to produce forecasts either every quarter, every month, or (for cash forecasting) every week or day.
  3. Planning monthly has motivated companies to go beyond the current fiscal year, and every month, either plan for a full 12 months ahead (rolling forecasts) or extend the plan at mid-year to include the full following year (concertina planning).
  4. Reporting at such detailed levels can be pointless if there is no plan to compare it with. So, companies are also motivated to plan at a more granular level – by project by department, for example. For personnel costs, this can mean planning for individual employees or at the job position level.
  5. With more granular planning, more meaningful variances are possible – not just ‘YTD company revenues are up by 10%,’ but ‘temporary help costs in the western region are 15% over plan,’ or ‘trailing twelve months (TTM) operating margins have been rising for the last six months.’

Companies use best-of-breed FP&A software to plan, report, and analyze financial data. Compared with manual spreadsheet alternatives, they can do this not only in greater detail but also more frequently, so planning processes are more accurate and timelier. This means that in “normal” economic circumstances, companies derive major benefits from using FP&A software.

But, even with detailed data and frequent planning, predicting the future does not come easy.  Business professionals, especially finance leaders, prefer the highest possible degree of certainty – “if it was successful in the past, it will be successful in the future” – because this maximizes the likelihood of meeting plans and forecasts.

Dealing with Uncertainty

Uncertainty is anathema to planners because it increases the risks of running a business. Unexpected events, such as economic downturns, make planning much more difficult but also increase the importance of being able to react to unexpected events by planning more frequently.

Most people are aware of the Wall Street Crash of 1929, but who has heard of the Credit Crisis of 1772 or the Panic of 1907? The reality is that economic downturns are nothing new and occur regularly.

The usual definition of a recession is when the economy is contracting for two or more consecutive quarters. This is a list of U.S. recessions since the 1960s:

Apr. 1960 to Feb. 1961 Federal Reserve raised interest rates
Dec. 1969 to Nov. 1970 Fiscal tightening to fund the Vietnam war
Nov. 1973 to Mar. 1975 Worldwide oil price shock
Jan. 1980 to Jul. 1980 1979 energy crisis; higher interest rates
Jul. 1981 to Nov. 1982 Continuation of the above
Jul. 1990 to Mar. 1991 1990 oil price shock; savings & loan crisis
Mar. 2001 to Nov. 2001 Dot-com bubble
Dec. 2007 to Jun. 2009 Subprime mortgage crisis
Mar. 2020 to? COVID-19

Roughly 1/7th of the time, from 1960 to 2020, the United States has been in one of nine recessions. Each recession lasts on average about 12 months, but recovery can easily take just as long. This means that the effects of these economic downturns and the related recoveries can last up to 1/3 of the time.

So, how can a company best prepare for shocks to the economy? What are the best practices?

Planning Best Practices

In times of market volatility, business environments change. Planning becomes much more important than during ‘normal’ times. With COVID-19, change has happened rapidly and economic expectations seem to change almost every month. Any company will have problems if ‘planning’ only means preparing the annual budget.

During COVID-19, Prophix customers have benefitted from having financial models of their business.

Here are some examples:

Scenario Planning – The ideal is having not just one ‘best guess,’ but exploring many different potential outcomes, both positive and negative.

Variance Analysis In a financial crisis, comparing multiple planned scenarios with what happens at a macro level indicates which scenario is the most likely outcome. This type of analysis gives senior executives a better feel of what is happening.

Frequent Timely Forecasting – When external economic conditions are rapidly changing, it is essential to produce reforecasts whenever new data becomes available. ‘Timely’ means that a new reforecast can be produced in a matter of days instead of weeks.

Cash Forecasting – When times are tough, cash is king. It is essential to meet the demands of payroll and banks. This can require monthly, weekly, or daily planning.

Personnel Planning – COVID-19 has affected labor costs in different ways. For many companies, it has meant furloughs and reductions in force (RIFs). In others, staff took pay reductions, while some companies grew quickly and hired more people. Each of these outcomes can give rise to sudden and substantive changes in labor costs, including not only salaries and wages, but also payroll taxes and other expenses.

Tracking Government Assistance – During a recession, government support can come in many different forms and can change almost monthly. Support can be, for example, loans for personal protective equipment (PPE), payroll protection programs, or government grants.

Sales PlanningSome companies import sales forecasts from their Customer Relationship Management (CRM) software to provide near-real-time forecasting. Changes in customers’ spending patterns will influence future revenues and indicate where to invest resources.

There is no one magic solution. Companies in different industries need to consider different information. Examples during COVID-19 are:

  1. Not-for-profit organizations forecast changes in their fundraising and how this will affect their ability to deliver on programs.
  2. Construction companies need to be on top of government projects designed to stimulate the economy and analyze how these can benefit their business.
  3. Professional sports teams will plan when they can start playing again and what form this will take. Television revenues may continue, but gate receipts and concessions revenues may disappear.

All these industries use FP&A software for their planning, and these examples all involve key changes to how companies plan. To be effective, their planning must be nimble (i.e. easily changed) and timely (i.e. quick to give the answers).

Because of this, the best run companies have a “planning culture,” where planning is not dependent on heavily manual processes, such as copying and pasting spreadsheet formulas and formats. For example, creating a new scenario or forecast is a repeatable process that should not require time-consuming manual input. With the correct tools, finance professionals can spend more time adding value to the organization by understanding how the business operates.

The tools that support a planning culture are available in FP&A software solutions like Prophix. Planning best practices require the planning process to be nimble and timely, and this is no longer just an aspiration but a reality.

Economic uncertainty is not unusual. Being able to manage a company through times of economic instability requires nimble, timely planning. However, it is important to distinguish between “planning” and “the plan”.

Companies should never slavishly follow any one plan – this is the old way of planning where the annual budget was all that counted. The reality is that as soon as a plan is finalized it becomes obsolete.

This does not mean that planning is a waste of time. The act of planning itself forces people to think about what might happen in the future, and gives insight into the risks and opportunities of navigating a company’s path through times of market uncertainty.

The best-run finance departments have a planning culture where they understand the business, quickly react to changes in external factors, and help senior management guide the company through turbulent times.

Paul Barber

Paul has worked in the software industry for over thirty years in such areas as Decision Support Systems, Executive Information Systems, Business Intelligence, and Corporate Performance Management.